Feb 18

Letter #87: BlockFi Interest Accounts vs. the U.S. Government - Round Two

Read now to learn how the recent settlement between BlockFi and the SEC is a clear example of the regulator favoring traditional banks over crypto firms.

Open in playerListen on);
Your one-stop shop for Bitcoin education!
Episode details

Dear Readers,

In what many inside and outside the Bitcoin and Crypto space are considering a watershed moment, BlockFi, a crypto lending firm, has agreed to pay a $100 million fine to various regulators, including the U.S. Securities and Exchange Commission (SEC), and to stop offering its primary product, the BlockFi Interest Account, to new customers within the United States. People in favor of the development have espoused the belief that the settlement provides a significant amount of clarity for companies offering crypto banking services. Perhaps in their mind, clarity from a government regulator is its own reward, no matter the costs.

Setting aside the fact that the might of the SEC’s furor is no longer hanging over the head of BlockFi, its customers and its investors, it’s worth playing the devil’s advocate since it seems clear that this development is far from completely positive. In doing so, I hope that we can together pick apart a few pieces of the SEC’s argument as they established in their own press release:

Lending Products Are Securities?

For those who don’t know, the SEC’s primary role is that of regulating any asset available for sale or distribution to U.S. citizens that is or should be classified as a security, or investment contract. Most people in the U.S. typically don’t think of an interest account as an investment contract. After all, the majority of citizens can access an interest account relatively easily through their local bank or credit union. However, the SEC appears to be arguing quite profusely that it considers the BlockFi Interest Account and similar products from other crypto firms to be securities:

BlockFi agreed to…cease its unregistered offers and sales of the lending product, BlockFi Interest Accounts (BIAs), and attempt to bring its business within the Investment Company Act…[by registering] under the Securities Act of 1933 the offer and sale of a new lending product.

My intent here is not to argue whether or not the SEC has the right to define what is and isn’t a security. However, it should be easily apparent that the SEC is not applying its belief that lending products are securities uniformly across financial companies. Ultimately, a crypto interest account is nearly identical in form and function to the interest account one can open at a traditional bank. In both cases, an individual lends an asset, either fiat currency or cryptocurrency, to a depository institution that takes the lent assets and re-lends them to a mix of institutional and retail users. But in the case of crypto firms, they are now required to register their interest accounts as securities and be subject to a lot of extra regulation, while their counterparts in the traditional financial space don’t have the same obligation. In simple terms, the SEC has unduly burdened crypto firms with restrictions that it has shown no intent over the ninety years since it was established to impose against similarly structured companies in the traditional finance industry.


I can imagine some observers maybe contemplating one or both of the following counterarguments:

Interest accounts at banks are FDIC-insured

Accounts at FDIC-compliant banks are typically insured up to a certain amount, usually $250,000 per person. However, deposits above the insured amount receive essentially no protection from the FDIC:

If a depositor has uninsured funds (i.e., funds above the insured limit), they may recover some portion of their uninsured funds from the proceeds from the sale of failed bank assets. However, it can take several years to sell off the assets of a failed bank. As assets are sold, depositors who had uninsured funds usually receive periodic payments (on a pro-rata "cents on the dollar" basis) on their remaining claim.

The question then becomes whether banks are required to register interest accounts as securities anytime the account holder’s balance exceeds the insured amount. If not, then it would be next to impossible to argue that crypto interest accounts are securities because they aren’t FDIC-insured.

The SEC’s press release specifically called BlockFi out for providing “a variable interest rate”

The thought process here could be that variable interest rates drive crypto interest accounts into the realm of “Profits Derived from Efforts of Others” as defined by the SEC’s main tool for identifying securities, the Howey test:

The main issue…under the Howey test is whether a purchaser has a reasonable expectation of profits (or other financial returns) derived from the efforts of others.

As we already discussed, BlockFi and other crypto firms generate funds with which to pay interest account holders by lending deposited assets to retail and institutional users. As a result, BlockFi’s ability to generate any interest rate is, for all intents and purposes, subject to a) market conditions and b) BlockFi’s efforts to locate and engage counterparties for its lending desk.

As I mentioned before, my intent isn’t to agree with or refute the SEC’s authority to enforce securities law. That said, it’s once again painfully obvious that the SEC is treating traditional banks one way and crypto banks another. For starters, the interest rates offered by traditional banks, pitifully low as they are, are also variable. Just look at the following disclaimer from JP Morgan Chase, the largest bank in the U.S., about the interest rates tied to its savings accounts:

It should also come as no surprise that the ability of traditional banks to pay interest is derived primarily from the banks’ ability to lend out depositors’ funds and generate yield.

Whether you are in support of or against the recent settlement between BlockFi and the SEC, it should be unsettling to say the least to see the blatant favoritism on display from a regulator whose stated goal is to “protect investors by enforcing our nation’s securities laws”. Such a goal can only be accomplished when the SEC fairly and uniformly enforces those laws against similar companies or companies with similar offerings, regardless of the industry in which those companies operate.

Like what you see, but not a subscriber yet?

Consider subscribing for two weekly emails about Bitcoin and Crypto, subscriber giveaways, real-time community discussions and more!

Can’t Get Enough Bitcoin In Your Life? Follow me on Social Media:

Follow Me

Bitcoin is my passion and my mission is to give as many people as possible the chance to learn how it can change their lives for the better. Want to support me and my mission?

Make a Donation

Blockchain Word of the Day

Want to learn more Blockchain words?

Check Out The Glossary

🙋🏽‍♂️Did you enjoy this edition of The HiFi Crypto Letters?

This 3-question survey is your chance to tell me how I can improve the newsletter for you.

Share Your Thoughts

This is not financial advice. This newsletter and related content are for informational purposes only. Cryptocurrencies and digital assets can be risky. Always do your own research before making any sort of investment.